How Luxembourg’s fund sector withstood the acute phase of the Covid crisis was summarised by the CSSF in its recently published 2020 annual report. Generally, the regulator was pleased with the performance on risk and liquidity, but it drew attention to some potential weak spots.
“The vast majority of funds surveyed were able to meet redemption requests and maintain portfolio structure,” said the report. Yet the CSSF mentioned that the tough part of the Covid crisis had been relatively short and that governments and central banks had flooded the global economy with liquidity.
Limited restrictions
Indeed, although total net assets of Luxembourg regulated funds dropped by -11.1% in March 2020, investors stayed relatively calm. Less than a quarter of this decline was due to the net effect of investors redeeming their holdings, with the lion’s share of the drop attributed to movements in underlying investments.
Only a “limited number” of funds used “gating” techniques to prevent withdrawals and redemption suspensions were only used on “an extremely exceptional basis”. However, swing pricing (which penalises investors which redeem their holdings) was “the most used liquidity management tool”. More specifically, no money market funds used gating, imposed liquidity fees, nor suspended redemptions.
Overall compliance, but…
The CSSF reinforced its market and risk supervision activity, notably through close follow-up of the redemption and liquidity activity of major management companies (ManCos). It worked with a panel of 120 leading ManCos representing over 90% of net assets. As well, as part of an ESMA survey started pre-crisis, the CSSF focused on 51 managers and more than 400 funds.
While revealing that managers were “overall compliant with the regulations in force” the regulator noted the need “for improvement of certain practices” particularly “pre-investment liquidity controls.” It also called for more effort with “liquidity risk management processes that are integrated in the internal procedures, including the quality and reliability control arrangements of the data used.”
Room for improvement
The CSSF also wants to see governance improvements, including more exhaustive documentation on liquidity risk assessments when launching new products. There were also question marks about the thresholds used when deciding when to report liquidity concerns to senior management and that “a rather small number of liquidity threshold crossings have been reported,” said the report.
The comment was also made that “control functions (in particular the compliance and internal audit functions) must be strengthened and carried out more frequently.” Moreover, there was a reminder that explanations of liquidity risk must be explained well to investors.
Alternative fund concerns
There were additional concerns about alternative funds. A couple of surveys of a representative sample were conducted and the CSSF found corporate debt and real estate funds to be “relatively well prepared for potential future adverse shocks” and that during the Covid crisis “only a limited number of the analysed funds had to be suspended, mostly as a consequence of valuation issues.” Moreover, for real estate funds it found that in general subscription requests exceeded redemption requests.
Nevertheless, the CSSF did raise some red flags after its investigations regarding real estate investment funds. It found that 40% of the ManCos had not included provisions for valuation under stressed market conditions in their valuation policy. During the crisis, 8% of funds experienced cash flow disruptions (such as non-payment of rent), and that 19% of funds using leverage experienced difficulties with meeting obligations linked to significant loans.